Innovations and International Trade

Innovation plays a key role in the theory of economic growth, but it contains different elements. These can be divided into two broad categories – process innovations and product innovations. The former may also be named ‘cost-reducing innovations’ in the sense that they take place through the discovery of new processes to produce the old products at lower costs. By contrast, the latter may be called ‘quality-improving innovations’ since they occur through the creation of new, higher- quality products. Both categories of innovations are, of course, important as engines of economic development, but their implications for economic welfare can vary enormously from time to time and from place to place. In poor economies in the early stage of development, process innovations in the daily necessities contribute significantly to the life of people. In affluent societies in the modern age, however, ‘it would be a terribly dull life if innovations only reduced costs of producing the same menu of goods and services that now populate their markets’.1 Product innovations are crucially important in such a situation. This chapter compares the welfare implications of cost-reducing and quality-improving innovations in the context of modern international economies in which both poor and affluent countries coexist and interact.